1 The Nature of Business
1.1 What Businesses Do
1.1.1 Define a business
A business (firm) is any organisation that uses resources to create goods or services (products) for its customers
1.1.2 What is business
activity?
Business activities refer to the organisational action of firms in:
• Taking inputs ie workers machinery raw materials components finance and
• Transforming (process or change) them into
• Outputs ie goods or services (products) and waste, noise and pollution
1.1.3 Illustrate business
activity
Manage Inputs
workers
equipment
raw materials
premises
finance
Manage
Transformation
process
Firms combine inputs to
produce products that meet
customers wants and needs
Manage Outputs
Products ie goods
& services
Pollution & Noise
Waste products
1.1.4 What are inputs?
Inputs refer to all the resources used by a firm to create products eg, people (workers, managers and owners), raw materials and
components, plant and machinery and capital eg money to buy stocks
1.1.5 How are inputs
classified in economics
In economics, inputs are called resources or factors of production and are classified under four headings:
• Land: all natural resources (gifts of nature) including fields, mineral wealth, and fishing stocks
• Labour: The physical and mental work of people whether by hand, by brain, skilled or unskilled
• Capital: All man-made tools and machines used to produce more goods including factories (plant), machines and roads.
Capital means investment in goods that produce other goods in the future.
• Enterprise: All managers and organisers sometimes called entrepreneurs or a firm.
1.1.6 How are factors of
production rewarded?
Owners of land receive rent; labour wages or salaries; owners of capital, interest and entrepreneurs profit.
In market economies, entrepreneurs risk capital (money), organise land labour and capital, to produce goods or services for sale.
If revenue exceeds costs a profit is made. Unsuccessful loss making firms fail to cover costs of their activities.
Firms have a big incentive
to make a profit – reward &
survival
1.1.7 Who coordinates a
firm’s activities?
Managers (or owners in small firms) are the staff responsible for decision making ie for determining what to do and for getting it
done. This involves organising inputs, transformation and outputs to ensure the objectives of a firm are met
• Arrange the right amount and mix of inputs at lowest cost
• Ensure the most efficient transformation process so that
• Outputs are created at lowest costs and unwanted production is minimised
1.1.8 What is the
transformation process?
The transformation process is where a firm takes inputs and turns extracts, builds, farms, refines, designs, manufactures etc into
finished goods and services. There are often unwanted spill over effects eg pollution
1.1.9 Define outputs
Outputs result from firms transforming inputs into products. unwanted pollution noise & waste products may also result
1.1.10 What is a product?
A product is any item that satisfies a want or a need and can be either
• goods: physical items such as food or
• services: non-physical items such as heating
1.1.11 Consumption is?
•
Managers are expected to
have ideas and make
decisions
Both goods and services
satisfy a want or a need
Consumption is the use of a good or a service by consumers (households) to satisfy a want or a need
1.1.12 Distinguish between
consumer & producer goods
Consumer goods satisfy wants and needs now. Producer, capital or investment goods such as plant (factories) and machinery
(equipment) are useful not in themselves but for the goods and services they can help produce in the future.
1.1.13 How are consumer
goods classified?
Convenience goods are products purchased by households and used only once eg food and drink. Sometimes called fast moving
consumer goods (fmcg). Consumer durables are goods bought by and used repeatedly eg a DVD
1.1.14 How do firms add
value
Firms process (transform) inputs such as natural resources (eg land), capital such as plant and machinery, workers and managers
into outputs ie goods (tangible) and services (intangible) that satisfy consumer wants.
Competitive firms add more
value than rivals
1.1.15 How is value added
calculated
Value added is the difference between the cost of inputs (total cost or TC) and the total revenue (TR) received from the sale of
outputs. Eg if TC =£500 and TR = £600 then value added = £100.
Value added is sometimes
called profit.
1.1.16 How can firms
increase value added?
Firms can seek to add value by persuading customers to pay more for a product or by reducing costs through:
Value added is also know as
gross profit
1.1.17 Customer loyalty?
•
Design using research and development (R&D) to improve the functions (what an item does) or look of a product
•
•
Production eg increasing outputs from given inputs or improving the quality of a product
Marketing using effective promotion to crate a brand image for a product and then charge a higher price
Firms build customer loyalty by offering products giving excellent value for money compared with rivals.
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1.1.18 Where do profits go?
If total revenue from sales is greater than total cost then a firm makes a profit. It can use either:
• Distribute profits to reward owners for risk taking and investing capital by paying dividends – one dividend for each
shared owned
• Retain profit (undistributed profits) to finance investment and growth
• Pay taxes on profits to the government
1.1.19 What happens if a
firm makes a loss
A loss occurs where costs exceed revenues. Losses can be met from past savings or by securing a loan but sustained losses
threaten the long term survival of the business
1.1.20 Is production the only
output of a firm?
Firms intend to just produce goods and services but there are almost always unintended side or spillover effects from production.
Factory owners can unintentionally generate:
• Pollution ie waste materials like smoke and effluent
• Noise & waste products eg seconds or unsold stock past its well by date
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Retaining profits reduces
dividends now but
investment may boost
future dividends – and the
price of shares
Governments use laws to
ensure firms and consumers
take full account of their
spill over action
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1.2 Specialisation
1.2.1 What is
specialisation?
Specialisation happens when an individual, region or country concentrates in making just one good. Specialisation enables more
efficient organisation of production with a series of distinct tasks but creates interdependence.
1.2.2 What are core
competencies?
Each business has its own unique abilities and strengths, ie core competencies or capabilities, in producing a given product. Core
competencies can stem from the way in which the firm uses its resources, staff experience and expertise; the product range and
image; R&D resulting in innovative products; its distribution network, etc.
Core competencies are
activities a believes it does
best, and should focus on.
1.2.3 Why do firms
specialise in certain
products?
Specialisation in the production of specific types of goods or services allows a firm to:
• ‘play to its strengths’ ie build on its core competencies.
• Over time experience further improves expertise and the firms learns what customers want from that product.
• Consumers begin to associate that firm with that product eg Heinz make good baked beans
Will customers buy a new
product outside an established
specialism eg Heinz ice cream?
1.2.4 Explain
diversification
Diversification involves targeting a new market with a new product. Diversification is a high risk strategy because the firm is
moving outside its areas of core competency.
1.2.5 Why diversify?
Firms diversify when companies find existing markets too competitive static or in decline or the firm wants to spread risk across
several products
1.2.6 Define the Division of
Labour
The division of labour is a particular type of specialisation where the production of a good is broken up into many separate tasks
each performed by one person, commonly on a factory production line.
1.2.7 Why does the Division
of Labour raise
productivity?
The division of labour raises productivity (output per person), thereby reducing costs per unit, for the following reasons:
• Workers become more practised at performing a given task.
• Output per worker (productivity) rises
• Workers are able to be trained more precisely for the task
1.2.8 Why do firms hire
specialist workers?
A business benefits by asking workers to concentrate on the one task they do best eg in a garage a worker:
• ‘good with numbers’ keeps the business’s books and issues invoices
• ‘good with engines’ is the mechanic
Accountants are not always
good mechanics; Mechanics
can be weak with numbers
1.2.9 As firms grow what
departments emerge?
As firms grow the organisation becomes more complex with the opportunity for specialisation by function:
• Accounts responsible for collecting financial information needed to forecast, plan, control and monitor the business.
• Production or Operations responsible for producing goods at lowest unit cost and highest quality
• Personnel or Human Resource Management (HRM) responsible for recruitment, salaries and training
• Marketing responsible for identifying products that meet customer needs profitably
Business functions refer to
the activities of different
departments eg marketing
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1.2.10 What are economic
sectors?
For the purposes of analysis the production of goods and services can be classified into four groupings
• Primary sector involving extraction of natural resources eg agriculture, forestry, fishing, quarrying, and mining.
• Secondary sector involving the production of goods in the economy, ie transforming materials produced by the primary
sector eg energy manufacturing and construction
• Tertiary sector providing services such as banking, finance, insurance, retail, education and transport,
Quaternary sector
involving information
processing eg financial
services such as
accountancy
1.3 Stakeholders see also Stakeholder Objectives
1.3.1 What is a
stakeholder?
A stakeholder is any individual or organisation interested in or affected by a firm’s activities. There are
• Internal stakeholders within a firm: managers & employees
• External stakeholders outside a firm: customers, suppliers, creditors, etc
Stakeholders are a key
concept in business studies
1.3.2 What is the difference
between a shareholder and
a stakeholder?
Do not confuse shareholders with stakeholders:
• Shareholders are part owners of a limited company – they are just one stakeholder in a limited company
• Stakeholders are any group affected by the activities of a company eg workers and the community
1.3.3 Why must firms take
account of all its
stakeholders' views?
Any business that fails to meet the basic objectives of a given stakeholder group runs the risk of reduced profits or even business
failure. Eg Suppliers who are not paid on time may refuse to work with the firm in future. A disgruntled community attracts
negative press coverage.
A key issue facing managers
is how to balance the
different objectives of
different groups of
stakeholders
1.3.4 Western v Japanese
stakeholder attitudes
Japanese firms traditionally prioritise the interests of their employees amongst their stakeholders – this is changing in response to
a long recession. UK companies tend to prioritise the interests of their shareholders amongst their stakeholders.
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high salary & bonus
profits
Job security
growth
repeat business
paid on time
Managers
Owners
Suppliers
Stakeholder
objectives
secure job
high wages
create jobs so
lower unemploment
Government
Workers
good working
conditions
responsible firms
Pay corporation tax on
profits
Pay local rates
long holidays
Local residents
Creditors
Pressure Groups
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noise
low price
high quality
want no
road congestion
Customers
pollution
paid on time
ethical behaviour
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1.4 What Businesses Need
1.4.1 What does a business
need to start trading?
To start and sustain its operations a business needs
• Finance: money to pay for capital equipment, premises, etc
• Labour to produce the good or service
• Customers to buy products on a regular basis
• Suppliers to provide raw materials and components
• Organisation and structures to co-ordinate complex business activities eg finance, personnel and production
Financial capital the money
a firm has fund its activities
and physical capital the
amount of plant &
machinery a business has
1.4.2 Define business
finance.
Business finance is the money needed to fund the activities of the firm eg:
• To purchase capital equipment or premises
• For working capital ie day to day money needed to pay bills and additions to stocks
• Expansion eg opening new branches or a takeover
• Unforeseen circumstances eg a recession sees a downturn in sales or a large customer fails to pay a debt
Financial capital refers to
the amount of money used
within a business.
1.4.3 Explain short and long
run finance?
Financial requirements are time related
• short term (up to one year) eg an overdraft to finance working capital,
• medium term 1-5 years eg a bank loan to finance equipment
• and long term 5 years + eg sale of shares to finance expansion.
It is not wise to use an
overdraft to finance the
purchase of equipment
1.4.4 How can an
entrepreneur finance a new
business start up?
The entrepreneur may use savings, redundancy pay, bank loans, borrow from family and friends, take on a partner, etc. The amount
and source depends on set up costs, concerns re sharing ownership or accepting risk. New firms find it difficult to rains finance
from banks, without offering personal assets as security.
1.4.5 What are the internal
sources of finance open to a
firm?
A firm can raise finance from within the business through:
• Retained profit. When a firm makes a profit it pays corporation tax to the government. The remaining net profit can be
either paid out as dividends or retained for investment
• Sale of assets eg selling some branches to release funds for other uses
• Reducing working capital releases funds for other uses
An entrepreneur is a person
who accepts the risk and
rewards of starting and
operating a business
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1.4.6 What are the external
sources of finance open to a
firm?
A firm can raise finance from outside the business in the:
• Short term by bank overdrafts that carry high interest payments, are agreed in advance and can be called in at any time.
Trade credit suppliers offer 28 days credit. Delaying payment is a source of very short term capital but this can threaten
confidence in the firm. Debt factoring where a firm sells its debts to a factoring business who pay the firm say 90% of the
value of invoices now and collect the outstanding debt
• Medium term by: hire purchase, leasing or medium term bank loan are used to acquire medium term assets such as cars
or computers where monthly repayments are spread over up to 5 years. The firm gets the asset now that saves working
capital but interest is charged.
• Long term: through a business mortgage, issuing bonds (long term year IOUs paying interest) or sale of shares ie
equity finance or involve a venture capitalist (risk capital in return for part ownership the firm)
1.4.7 How can firms protect
ideas?
If a firm has an original idea it can gain legal protection through:
• Patents grant exclusive rights to produce a good to the inventor and so encourage R&D
• Copyright eg only Tutor2U can legally sell these notes
• Trademark eg coca-cola own the trademark on their soft drink bottle
1.4.8 What problems do
businesses face in the early
years?
Raising finance. Setting up a business is a risky process. The reward for success is independence and profit; the penalty for failure
is loss of money invested in the business and possibly loss of personal assets.
Owners of small firms may find the responsibility and uncertainty of ownership and management too stressful
1.4.9 Why do so many small
firms fail in the first year?
Small business face particular difficulties and fail in the early years because:
• Inadequate market research fails to identify customer needs or exaggerates potential sales.
• Insufficient demand to allow the firm to produce a quantity that covers costs and makes a profit
• Inadequate financial planning or control results in cash flow problems, over trading or failure to keep accurate records –
each major reasons for business failure
• Inadequate finance to survive initial period. Banks are reluctant to lend large sums to new companies without a trading
record or security
• Overtrading firms expand without securing funds to finance growth. There is insufficient working capital to pay for the
inputs needed to produce output. The resultant cash flow crisis is a major cause of insolvency in new firms.
• Bad management eg failure to keep records or a mistake in the design of a product, its pricing or location through lack of
experience in all areas of the business can jeopardise the firm
• It takes time to build market share– customers are unaware of the product and must be converted and retained.
• Changes in external factors. An unexpected economic downturn, failure to react to market trends, or new product/price
cut by from competitors can threaten the firm.
• Competition from larger firms who use their market power and economies of scale to set low prices
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Managers decide the best
type and source for finance
for a specific project, by
considering the repayment
period and cost of finance.
The business environment is
dynamic (constantly
changing) and firms that do
not adapt are unsuccessful.
Planning is an essential part
of managing the process of
change to adapt to new
conditions.
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1.5 Accountability
1.5.1 What is the role of
managers
Management is a process undertaken by employees responsible for:
• Setting objectives (where the firm aims to go) and a strategy to get there.
• Organising resources - human, financial and physical - to meet these objectives
• Providing leadership to motivate and inspire people and set the business culture
• Planning controlling and evaluating to ensure the business is on track to meet objectives
• Setting the organisational structure for the business ie departments and job descriptions
A manager may be efficient
at maximising outputs from
given inputs but have weak
leadership skills.
1.5.2 What is
organisational structure?
Organisational structure is the formal way a business is organised ie
the roles, responsibilities, hierarchy, lines of accountability, and the
chain of command within a business.
• Most businesses describe their organisational structure
with organisation charts
• The chain of command is the formal line of communication
and authority within the organisation.
Traditionally UK firms have many levels or layers of hierarchy – they
are tall. This adds to costs and can make communication difficult.
American firms prefer flatter organisational structures.
Hierarchy means ‘pecking
order’
NB charts do not show
informal structures and
communication channels.
Organisation Chart
Managing Director
Marketing Director
Market Research Manager
Assistant K
Assistant L
Advertising Manager
Assistant A
Assistant C
1.5.3 Are staff accountable
As a firm grows and takes on more employees each takes responsibility for a particular task reporting to their line manager.
Workers need authority to undertake delegated tasks.
1.5.4 Explain delegation
Delegation means authorising subordinates to perform certain tasks. There are three main aspects to delegation:
• Responsibility where a subordinate accepts liability for the outcome of a task.
• Accountability where subordinates answer to a supervisor or manager and justify their actions and decisions
• Authority where subordinates are given the power and resources to ensure a task or function is achieved. Eg subordinates
may be given a budget, the ability to hire or fire and set tasks for other employees.
1.5.5 Why is accountability
important
Holding staff accountable for tasks allows companies to run specialist departments
• monitor and evaluate business activity
• and can lead to high employee motivation.
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Delegation of tasks is often
linked to a SMART objective
and a budget identifying
month by month targets
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